What are some of the strongest currencies in the world?
Without resorting to the currency strength meters, we know that many strong currencies belong to the advance economies, such as the USD, GBP, EUR or JPY. These economies are stronger than many developing ones and hence are more ‘desirable’.
Whilst the USD is not the strongest currency in the world in terms of exchange rate value it should be considered the most powerful currency globally – since most other currencies are always measured against the USD. The first thing a FX trader will value up an exotic currency is to check it against the dollar.
There is another group of currencies that are strong because they are the so-called ‘hard currency’. These countries have plenty of natural resources such as oil. Exports of these resources earn the country plenty of profits and export earnings. Consequently their currency is backed by large forex reserves. The Kuwaiti Dinar and Brunei Dollar are two visible examples within this group.
And then there are currencies of major financial centres, such as the Swiss Franc (CHF) and Singaporean Dollar (SGD). These currencies benefitted significantly from the growth in international capital flows. The monthly USDCHF chart below tells you all you need to know about the long-term direction of the Swissie.
At times, however, these nations do not want such a strong currency. It makes their exports highly uncompetitive. Central banks of these countries often engage in accommodative measures (eg CHF negative interest rates) or direct interventions to cap the currency strength. The Bank of Japan occasionally intervenes in the market if it feels the currency is becoming too strong (or weak).
Overall, you generally want to invest in currencies (by invest I mean holding it over the years) that are exhibiting long-term upward trends.
It’s a recurring consensus that the USD is the strongest currency, and Senior Currency Strategist, Hamish Muress from OFX told us:
The dollar is king – possibly also followed by the Japanese Yen and Swiss Franc. Focussing on the USD though it is clear to see how times of huge uncertainty in the market sees investors flood back into the relatively safe US Dollar.
Typically all of these currencies perform well because investors look to park their assets US Treasuries, Japanese Government Bonds, or Swiss Government Bonds.
Why? Well investors reason that these countries will never default on their debt so they act as safe bets and in order to buy these underlying assets investors first of all need to purchase the domestic currency.
Hence we see in time of uncertainty or ‘risk off’ these currencies perform well.
If you are converting funds to USD, you can compare currency quotes from currency brokers here. Or if you are more interested in speculating or hedging on the foreign exchange markets you can do so through a Forex broker.
What is a currency and how do we measure its strength?
A currency is typically the legal tender of a sovereign nation. In the UK, the currency in circulation – and widely accepted as a form of payment – is officially Pound Sterling (GBP). By law, the institution largely responsible for issuing banknotes is the Bank of England.
Under normal economic circumstances, a strong or weak currency is hardly detected day to day. Over time, however, the cumulative impact of a currency trend will be felt keenly by all consumers and businesses.
In most advance economies, central banks and governments will attempt to make a currency stable. A volatile one benefits no one. Pricing of international goods, for one, becomes problematic. International trade will be severely affected since counterparties are often aggrieved by sharp movements in currencies.
In the past, the strength of a currency is solely measured against the US dollar – the linchpin of the international currency exchange and trade. The dollar is the world’s primary reserve currency (see below) and most commodities are priced against the US currency. Many major FX pairs typically have USD on one side, eg GBPUSD or USDJPY.
However, the problem with measuring the currency strength using just one currency – albeit the most traded one – is that multi-lateral trade volume has increased significantly for many countries in the past few decades.
Source: CFR (2024)
Take Great Britain. In the four quarters to June 2024, UK exported and imported billions of goods to multiple countries. To the US, UK exported goods and services worth £192 billion; to Germany, another £60 billion, and so on (see below). Euro-denominated countries occupy a significant chunk of UK trade.
So, should we use GBPUSD as a single measure of UK currency strength? I suppose not. There is a case for using multiply currency pairs to measure the strength of a currency.
Source: UK Gov (June 2024)
The emergence of the US Dollar Index (and other trade weighted currencies)
Due to the above problem, financial economists have developed trade-weighted measures of a currency to gauge its ‘true’ strength. The oldest and most well known is the US dollar Index.
According to the Intercontinental Exchange (ICE), the current owner of the Dollar Index derivatives:
The U.S. Dollar Index is a geometrically-averaged calculation of six currencies weighted against the U.S. dollar. The U.S. Dollar Index originally was developed by the U.S. Federal Reserve in 1973 to provide an external bilateral trade-weighted average value of the U.S. dollar as it freely floated against global currencies…….The U.S. Dollar Index contains six component currencies: the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.
The weighting of each currency pair in DXY is as follows: Euro 57.6 percent, Japanese Yen 13.6 percent, British Pound 11.9, Canadian Dollar 9.1 percent, Swedish Krona 4.2, Swiss Franc 3.6 percent. And the Dollar index is calculated with the following formula (ICE DXY factsheet):
Because DXY’s is derived from a few currency pairs, the result is a more stable time series (than a single FX).
Look closely at DXY’s historical trend below. The index is, broadly speaking, on an upward trajectory since 2008, with multi-year sideways consolidation range. It made a multi-year peak in 2022. Some say the US dollar is like a supertanker, it takes a lot of buying to move its value upwards; and plenty of selling to push it down. True. Individual pairs, say USDJPY, exhibit movements far in excess of the trend in DXY.
How currency strength can be used in investing and trading
The thing is, how should we trade or invest using ‘currency strength’?
This depends on your a) risk appetitive and b) objectives.
For trading, currency strength tables are used to filter the stronger currencies, so as to make bets in order to profit from movements in the exchange rates. In this regard, the trade-weighted currency indices are less useful because they are overly long term. Trading books need to be marked-to-market almost on a daily basis. Short-term price matters.
Thus many traders aggregate the prices of a base currency against other currencies, without resorting to fundamental economic data. For example, there is the website called currencystrengthmeter.org that publishes the strength of major FX using short-term prices:
Source: currencystrengthmeter.org
But there are almost countless ways to aggregate the ‘strength’ of a currency. Factors to consider when constructing these FX meter charts include:
- Pairs to use
- Weightings of each pair
- Calculation methods to measure the strength
- Technical indicators overlay
- Time horizon (short, medium or long)
As you can see, when these considerations are taken into account the topic becomes more involved and technical. Depending on your trading method, you will have search for a currency measurement that suit your style.
Turning to investing using currency strength, there is another critical element that influences the outcome: interest rates.
This is because professional investors engage in borrowing from low-cost currencies and then construct a complex series of transactions to take advantage of the high-interest currency. The most famous of this international FX trade is the ‘Yen Carry Trade‘.
The basic idea is this. Investors borrow in the Japanese Yen (with near-zero interest rate) and invest the proceeds in the US or UK (which offer 4-5 percent annual interest). Investors pocket the difference. As Yen is plenty (due to monetary easing), its FX value tend to depreciate over time. So investors repay their Yen loans at a lower rate. Double source of profits. By August this year (2024), some estimated that the Yen carry trade amounted to near $350 billion. A few disputed this figure. But whatever the exact amount, it is safe to say that the Yen Carry Trade is a large and consequential international FX trading program.
The problem is, when all traders and funds are stacked on one side of the trade, it becomes overcrowded. A scramble to reduce their leveraged Yen positions caused a mayhem in the FX market.
In August 2024, for example, the Japanese Yen promptly switched from one the weakest currencies to one of the strongest. USDJPY jumped a massive twenty points (a huge coverage) in a matter of weeks.
Jackson is a core part of the editorial team at GoodMoneyGuide.com.
With over 15 years industry experience as a financial analyst, he brings a wealth of knowledge and expertise to our content and readers.
Previously Jackson was the director of Stockcube Research as Head of Investors Intelligence. This pivotal role involved providing market timing advice and research to some of the world’s largest institutions and hedge funds.
Jackson brings a huge amount of expertise in areas as diverse as global macroeconomic investment strategy, statistical backtesting, asset allocation, and cross-asset research.
Jackson has a PhD in Finance from Durham University and has authored nearly 200 articles for GoodMoneyGuide.com.
You can contact Jackson at jackson@goodmoneyguide.com
